Getting to a Real Oversold Condition

So, now they say they are waiting on clarity regarding the fiscal cliff. Well, we now know what the true meaning of clarity is. It means they are dying to be bullish, but they need a deal done first.

Then the president spoke and everyone thought he might soften his stance, but instead he reiterated his higher taxes theme. Tell me something guys, in this day and age, when does the winner ever soften their stance? Nowadays winners take victory laps, they do not extend olive branches. Diplomacy has gone the way of the buggy whip.

But on Wednesday there was a new chink in the armor as the tensions in the Mideast flared, something that was not on the radar.

Let's put the news aside and look at the indicators. Yesterday, I noted how many of the intermediate-term indicators were still above their oversold levels. Wednesday's action took them down some more. For example, the Hi-Lo Indicator moved to 30% (from 37%). An oversold reading is under 20%. As a reminder, the June low reading was 17%.

Then there is the McClellan Summation Index. Yesterday, I noted that we would need at least a few more harsh down days to get the what-if indicator to where it required +4000 or more. What this means is that we do a what-if to determine what it would take to turn the Summation Index from the current down to up. As of today, this indicator would require a net differential of advancers minus decliners on the NYSE of +4500 to turn it from the current down to up. You can see on the chart that we are fast approaching the point of too much or oversold.

There have been times where this indicator has gotten to where it requires +6000 or a bit more than that, as you can see on the chart, but at this point we'd be looking at one or two more days at the most to get there. So, we can finally say we're getting to a proper oversold condition.

We did see a decline on Wednesday with 90% of the volume on the downside, but what really caught my eye was the Investors Intelligence readings that showed where if we combined the bears and the correction-minded folks we had 62%. As you can see on the chart, a combination over 65% has typically led to a tradable rally.

One thing to keep in mind is those extreme readings on the what-if of the McClellan Summation Index led to short-term rallies. It was the secondary low that gave the better rally sign. And considering the number of stocks at new lows soared to more than 200 on the NYSE, a reading we haven't seen in more than a year, there are no positive divergences. For that we would need a rally and a retest, the W pattern I refer to often.

If we can rally on Thursday and then come back down early next week with some positive divergences I think we could have a tradable rally. Without positive divergences, it'd be just an oversold rally.

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